Article

Overdrawn Account

Peter R. Orszag and William G. Gale

This article originally appeared in the New Republic

The administration’s new budget, released Monday, underscores its enthusiasm for both unaffordable tax cuts and massive asterisks. In case there were any lingering doubts, we now have unmistakable confirmation that the president’s top fiscal priority is large, regressive tax cuts under any and all circumstances.

Despite a rapidly deteriorating budget outlook, the administration’s budget emphasizes tax cuts that would cost well more than $1 trillion over the next ten years. The vast majority of this cost would come from making most features of the 2001 and 2003 tax cuts permanent. But rather than coming clean about the price tag, the administration attempts to mask the cost with a series of dubious accounting ploys. Indeed, though the central claim of the administration’s budget is that it cuts the deficit in half by 2009, it does so only by leaving out more than $150 billion in likely costs that year.

To take one example, administration officials have recognized that the coming explosion in the Alternative Minimum Tax (AMT) is untenable. Originally conceived to ensure that a small group of wealthy individuals (people otherwise prone to weaseling out of their tax liability) would pay some baseline level of taxes, under the administration’s budget the tax would apply to some 30 million Americans by 2009. In fact, almost a third of the president’s own 2001 tax cuts would be erased by the AMT by then. But the budget doesn’t include the $70 billion or so that it would cost to fix the problem that year. The president should either admit that the AMT will increasingly erase his beloved tax cuts, robbing families of the money he’s pretending to give them, or be honest about the costs of avoiding that outcome.

Furthermore, even if the administration’s plan magically succeeded in cutting the deficit in half, the budget would rapidly deteriorate pretty soon after that. That’s because the vast majority of the costs from extending the president’s tax cuts arise after 2009. To take our preferred metric, over the next 75 years, the tax cuts will cost more than three times the deficit that Social Security—a program ostensibly in crisis—faces over the same period.

The costs of the administration’s proposals for tax-free “Lifetime Savings Accounts” and “Retirement Savings Accounts” are also deceptively small. Because the tax breaks would come when the money is withdrawn, rather than when it’s deposited, the proposed programs would actually raise money in the first few years (as people pay taxes on the money they withdraw from existing retirement accounts to transfer into the new accounts). But the cost, in terms of lost tax revenue, would explode just as the baby boomers impose increasing burdens on the budget. Over the next 75 years, the cost of this new proposal would amount to about a third of the Social Security deficit.

Of course, that cost might have been worthwhile if the administration’s proposals were designed to address the problem—low national saving—they purport to fix. In fact, they would only make things worse. Since the “Lifetime Savings Accounts” and “Retirement Savings Accounts” wouldn’t be subject to any income limits, high-income households could simply shift money out of, say, mutual funds, and into the new accounts–in effect, earning a tax break for saving they were already doing. (According to our calculations, the top 10 percent of income-earners would ultimately enjoy more than two-thirds of the tax subsidy provided under this type of proposal.) Meanwhile, the administration’s proposed budget eliminates incentives for saving by low-income earners, which is where net additions to national saving are most likely to come from. Indeed, one of the few tax incentives the budget would allow to expire over the next ten years is the modest “saver’s credit,” which provides a progressive government match for contributions made by moderate-income households to 401(k)s or IRAs.

A final illustration of the administration’s dubious budget tactics comes in its proposals for new budget rules. In the late 1990s, rules requiring that every tax cut or spending increase be offset by a corresponding tax increase or spending cut helped guide policy-makers toward fiscal responsibility. Unfortunately, the administration’s proposed reincarnation of the rules sets constraints only on new spending, not new tax cuts. The problem is that the latter bear far more responsibility for the size of the deficit than the former. (Between 2000 and 2004, slightly more than 75 percent of the deterioration in the budget as share of GDP was due to lower revenue, not higher spending. Much of that lower revenue was a result of the tax cuts.) On top of that, such a rule would create strong incentives for disguising spending changes as revenue provisions—it’s just as easy to give, say, a big agricultural conglomerate a tax break as it is a farming subsidy—thereby creating what Alan Greenspan has called “tax entitlements.” These entitlements are every bit as damaging to the budget over the long run as spending entitlements, but they’re typically much more regressive.

Authors

Since the administration’s budget isn’t the right path for the nation, what is? Balancing the budget over time clearly requires a combination of spending restraint and revenue increases. On the revenue side, a key issue is the treatment of tax cuts currently slated to be phased out–or “sunsetted”–over the next few years. If these tax cuts are worth extending, they should be paid for by tax increases or spending cuts elsewhere in the budget. Meanwhile, though spending constraints should also be part of the package, they’re unlikely to be much help closing the budget gap over the next ten years. The administration claims to move toward its deficit reduction goal by putting the lid on non-defense, non-homeland security discretionary spending. But since that kind of spending accounts for a mere 18 percent of the budget, such restraint would generate only a few billion dollars in deficit reduction–peanuts along side a half-trillion dollar deficit. Then again, with so many tax cuts disguised as deficit reduction, maybe a few billion dollars of real deficit reduction is the best we can hope for.